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Making sure that you understand the difference between employees and independent contractors is crucial: getting it wrong can result in thousands of dollars of tax penalties, depending how long your workforce was incorrectly categorized.

The IRS has very specific rules on who can be considered an independent contractor. By default, it’s assumed that anyone working for your company is an employee and you’re liable for payroll taxes for such an individual. People working for you are considered contractors if, and only if, the following requirements are met.

1. Work Outcomes

An individual is an independent contractor or self-employed only if the organization he works for does not control the manner in which any work is completed — only the outcome of that work.

2. Benefits

You cannot provide independent contractors with benefits, such as insurance or vacation pay.

3. Supplies

You cannot provide tools or supplies to independent contractors.

4. Timing

You cannot require an independent contractor to work specific hours.
If you tell an individual when he or she needs to be at work or where to work on a project, he or she is an employee. You can tell an independent contractor when you need a project ready by and where to deliver it, but that’s as far as you can control the when and where of the work.

As you read these requirements, you may feel like even people who are obviously self-employed and work with you as vendors may accidentally fall under the category of employee without meaning to. In the event that the IRS reviews your employee classifications, it’s worth noting that the rules are written in such a way as to show that there are usually multiple factors that indicate whether someone is an employee or an independent contractor. Just because one or two factors are in play does not mean that the IRS will automatically reclassify the people that you work with.

Just the same, it’s important to make sure that you understand the differences. Do everything you can to make sure that the people who work for you as employees are clearly such and the people who work for you as independent contractors are clearly self-employed.